Weekend Reading: Diane Coyle (2012): Do Economic Crises Reflect Crises in Economics?

Diane Coyle (2012): Do Economic Crises Reflect Crises in Economics?: “The problems with economics: (1) Theory…

…There is a well-known joke about economic methodology. Two friends are walking along when one spots a €50 note on the floor. “Look!” he says, “Let’s pick up the money.” His friend, an economist, replies: “No, don’t bother. If it were really there, somebody would have picked it up already.” The joke of course is about the lack of realism in the assumptions economists conventionally make in order to analyse the real world….

In practice, the version of this assumption used in applied analysis is rarely as strong. In practice, it is more like: given the limited information available to them, and the various transaction costs they face in taking certain courses of action, and given that the future is very uncertain, we’ll assume people act broadly in their self-interest, however they would define that. I would strongly defend the use of this contingent version of the standard assumption as it’s a powerful analytical tool…. Modern institutional economics, which is a thriving area of research, is founded on the use of the rationality assumption as a tool of analysis. If people do not seem to be making the rational choice, then looking at the difference between what would happen if they did so and the reality is instructive….

I would defend using the assumption of rational choice as long as one realises that it is not a description of reality. But there is one area where for 30 years economists – and others – have been making that mistake. That is, unfortunately, of course, in the financial markets. Practitioners and policy makers acted as if the strong form of the Efficient Markets Hypothesis held true – in other words that prices instantly reflect all relevant information about the future – even though this evidently defies reality. What’s more, a political philosophy valuing limited government leapt on what was taken as proof that markets left to themselves deliver better economic outcomes. This was translated as the deregulation of markets, especially financial markets, and became entwined with the growing importance of the finance sector in the economy globally. So politics fed the trend. The computer and communications technologies fed the trend as well, by making more and more financial transactions possible.

I think an honest conventionally-trained economist has to at least acknowledge that we grew intellectually lazy…. A particular ideological version of economics became the framework for analysing public policy, and very few mainstream economists challenged that. We got on with our work and ignored the importance of the public rhetoric….

A looser version is that a public sphere founded on the world view of narrow, rational choice economic models has over time led people to behave like the selfish, calculating beings assumed in those models. If regulations assume that you are going to behave in a certain way, there must surely be a temptation to live up to the assumption. I don’t know if this theory of economic performativity is true; perhaps the causality runs the other way, and a period of free-market politics especially in the US and UK changed the character of economics? We can’t test these alternatives, but this criticism is worth considering….

The financial and economic crisis [thus] spells a crisis for certain areas of economics, or approaches to economics. Financial economics and macroeconomics are particularly vulnerable. They are the subject areas where the consequences of the standard assumptions have been most damaging, because they are actually least valid. Financial market traders are not remotely like Star Trek’s Mr Spock, making rational calculations unaffected by emotion or by the decisions of other people. Macroeconomics – the study of how millions of individual decisions aggregate into economy-wide measures – is essentially ideological. How macroeconomists answer a question like ‘What will be the effect of cutting the budget deficit on growth next year?’ depends on their political views. This is not remotely a scientific area of the discipline….

I can’t omit here a few other problems with economics as it has been practised… the economics curriculum in universities… gives too much time to macroeconomics, on which as I just argued there is no professional consensus…. They have little sense of economic history…. Students are also not systematically taught new aspects of the subject…. Undergraduates are also taught as if they are all planning to go on to study for a doctorate and become academic economist…. Finally, many of these under-cooked economics graduates go on to work in government…. There are some good reasons for this special status – I’m about to come on to those – but the influence economists have in government needs seasoning with a corresponding degree of humility. One side-effect of the crisis may be to make economists a bit more humble, which would be a good result.

Must-Read: John Voorheis, Nolan McCarty, and Boris Shor: Unequal Incomes, Ideology and Gridlock: How Rising Inequality Increases Political Polarization

Must-Read: John Voorheis, Nolan McCarty, and Boris Shor: Unequal Incomes, Ideology and Gridlock: How Rising Inequality Increases Political Polarization: “Income inequality has a large, positive and statistically significant effect on political polarization…

…Economic inequality appears to cause state Democratic parties to become more liberal. Inequality, however, moves state legislatures to the right overall. Such findings suggest that the effect of income inequality impacts polarization by replacing moderate Democratic legislators with Republicans…

Must-Read: Paul Krugman: Angus Deaton and the Dodd-Frank Election

Must-Read: Paul Krugman: Angus Deaton and the Dodd-Frank Election: “Angus Deaton has won the Nobel, which is wonderful…

…a fine writer with important things to say about political economy. Cardiff Garcia excerpts a passage in which he explains why we should care about the concentration of wealth at the top:

[T]here is a danger that the rapid growth of top incomes can become self-reinforcing through the political access that money can bring. Rules… set not in the public interest but in the interest of the rich, who use those rules to become yet richer…. To worry about these consequences of extreme inequality has nothing to do with being envious of the rich and everything to do with the fear that rapidly growing top incomes are a threat to the wellbeing of everyone else…

Confessore, Cohen, and Yourish documents… that campaign finance this election cycle is dominated by a tiny number of [the] extremely wealthy… overwhelmingly flowing to Republicans…. The biggest piece of the super-rich-super-donor story is money from the financial sector. And there has… been a huge swing of finance capital away from Democrats to Republicans that began… after the passage of financial reform…. the people who brought you the financial crisis trying to buy the chance to do it all over again.

Angus Deaton and the Dodd Frank Election The New York Times

Note that “finance” as a whole was split 50-50 in the money it gave in 2008, and split 75-25 Republican in the money it gave before 2008–Tom Ferguson of U.Mass is the Master of All Who Know on these issues. “Hedge funds” are (or were) people who were not terribly invested in the pre-2009 structure of Wall Street, were relatively young, and were much more Democratic than finance as a whole even before 2008. Their swing to the Republicans is very bad news. You would think that after Arthur Burns’s inflation, Ronald Reagan’s deficits, and Ben Bernanke’s financial crisis that they would be wary. Economic regulation is onerous. But macroeconomic mismanagement is disastrous.

But no…

Must-Read; Weijia Li: Party-State Relationships in One-Party Regimes

Must-Read: Weijia Li: Party-State Relationships in One-Party Regimes: “Although China and Soviet Union are both Communist regimes…

…they… feature very different party-state relationships. In contemporary China, the party secretary exerts political leadership, but fiscal and economic power is delegated to the governor. In the Soviet Union, the party secretary retained substantial and comprehensive economic power. I argue that the difference can be attributed to the discrepancy between market economy and planned economy. Using a simple growth model, I derive economic consequences of fiscal delegation that are consistent with empirical regularities. The delegation of fiscal power drastically reduces central authority’s concern about local officials’ loyalty… solves a major dilemma between loyalty and competence in autocracy… promotes political stability and meritocracy in China…

Must-Read: Paul Krugman: Puzzled By Peter Gourevitch

Must-Read: Over the past twenty years, Paul Krugman has a very good track record as an economic and a political-economic analyst. His track record is so good, in fact, that any even half-rational or half reality-based organization that ever publishes a headline saying “Paul Krugman is wrong” would find itself also publishing at least five times as many headlines saying “Paul Krugman is right”. And when any organization finds itself publishing “Paul Krugman is wrong” headlines that are not vastly outnumbered by its “Paul Krugman is right” headlines, it is doing something very wrong.

Thus note this “Paul Krugman is wrong” headline from the Washington Post’s Monkey Cage:

In the article, the well-respected Peter Gourevitch puzzled and continues to puzzle Paul Krugman:

Paul Krugman: Puzzled By Peter Gourevitch: “Peter Gourevitch has a followup… that leaves me, if anything…

…more puzzled…. He notes that….

The Federal Reserve is not a seminar… not only about being ‘serious’ or ‘smart’ or ‘finding the right theory’ or getting the data right. It is… a political… multiple forces of pressure: the… Committee; Congress and the president… political parties… interest groups… media… markets… foreign governments and countries.

But how does that differ from what I’ve been saying?…

[My original] column… was all about trying to understand the political economy of a debate in which the straight economics seems to give a clear answer, but the Fed doesn’t want to accept that…. I asked who has an interest… my answer is that bankers have the motive and the means….

I talk all the time about interests and political pressures; the ‘device of the Very Serious People’ isn’t about stupidity, it’s about how political and social pressures induce conformity within the elite on certain economic views, even in the face of contrary evidence. Am I facing another version of the caricature of the dumb economist who knows nothing beyond his models? Or is all this basically a complaint that I haven’t cited enough political science literature? I remain quite puzzled.

I agree.

It puzzles me too.

So let’s look at the arguments: In what respects does Peter Gourevitch think that Paul Krugman is wrong about the Federal Reserve?

(1) Here we have, for one thing, a complaint that Paul Krugman should not believe that there is even a “correct” monetary policy that the Fed should follow. This criticism seems to me to take an “opinions of the shape of the earth differ” form. I reject this completely and utterly.

(2) Here we have, for another thing, Peter Gourevitch saying–at least I read him as saying–that: “Paul Krugman is wrong! Political science has better answers! Political science better explains the Federal Reserve’s actions than Paul Krugman does!”

Yet Gourevitch does not actually do any political science.

He does not produce any better alternative explanations than Krugman offers.

In lieu of offering any such better alternative explanations, at the end of his follow-up post he provides a true laundry list of references for further reading:

  • William Roberts Clark, Vincent Arel-Bundock. 2013. “Independent but not Indifferent: Partisan Bias in Monetary Policy at the Fed.” Economics & Politics 25, 1 (March):1-26.
  • Lawrence Broz, The Federal Reserve’s Coalition in Congress. Broz looks at roll calls in Congress to explore left and right influences on the Fed.
  • Chris Adolph, Bankers, Bureaucrats and Central Bank Policy: the myth of neutrality, Cambridge University Press 2013
  • John T. Woolley. Monetary Politics. The Federal Reserve and the Politics of Monetary Policy. 1986. * Thomas Havrilesky. The Pressures on American Monetary Policy. Kluwer 1993.
  • Cornelia Woll, The Power of Inaction.
  • Kelly H. Chang. Appointing Central Bankers: The Politics of Monetary Policy in the United States. Cambridge UP 2003.
  • Jeff Frieden, Currency Politics: The Political Economy of Exchange Rate Policy
  • Roger Lowenstein, America’s Bank: The Epic Struggle to Create the Federal Reserve (suggested by Jeff Frieden).
  • Bob Kuttner’s Debtors’ Prison
  • Mark Blyth, Austerity.
  • Paul Pierson and Jacob Hacker, American Amnesia: Rediscovering the Forgotten Roots of Prosperity.
  • Greta R. Krippner, Capitalizing on Crisis: The Political Origins of the Rise of Finance
  • Marion Fourcade, Economists and Societies: Discipline and Profession in the United States, Britain, and France, 1890s to 1990s; 2015
  • Marion Fourcade, “The Superiority of Economists” (with Etienne Ollion and Yann Algan), Journal of Economic Perspectives; 2013
  • Marion Fourcade, “Moral Categories in the Financial Crisis.”
  • Marion Fourcade, “Introduction” (with Cornelia Woll)
  • Marion Fourcade, “The Economy as Morality Play” Socio-Economic Review 11: 601-627.

18 references. Some of them are quite long. Figure roughly 3000 pages. Or roughly 1,000,000 words. Offered without guidance.

As one of my Doktorgrossväter, Alexander Gerschenkron, used to say: “to tell someone to read everything is to tell him to read nothing.”

So let me provide some guidance: If you are going to read one thing from Peter Gourevitch’s list, read Mark Blyth’s excellent Austerity. I do think it is the place to start.

And if you do read it, you will find a very strong book-length argument–an argument which carries the implications that Paul Krugman’s screeds against and anathemas of VSPs are not, as analytical explanations, wrong, but rather profoundly right.

Must-Read: Dani Rodrik: Trade within versus Between Nations

Must-Read: Dani Rodrik: Trade within versus Between Nations: “The proper response to the question ‘is free trade good?’…

…is, as always, ‘it depends.’… Many of the conditions under which free trade between nations is guaranteed to be desirable are unlikely to hold in practice. Market imperfections, returns to scale, macro imbalances, absence of first-best policy instruments are ubiquitous… particularly in the developing world…. This does not guarantee that import restrictions will be necessarily desirable. There are many ways in which governments can screw up…. But it does mean that a knee-jerk free trader response is faith-based…. OK then, what about trade restrictions within nations? If I am a skeptic on free trade between nations, should I not be a skeptic on trade within a nation as well?

No…. The set of circumstances under which free trade within a nation may be undesirable is substantially smaller than the set of circumstances under which free trade between nations is undesirable…. Consider a case where a region loses out from trade within a nation–say because it de-industrializes rapidly and ends up specializing in technologically non-dynamic primary activities…. The workers in that region can migrate…. There is an overarching state that will engage in transfer payments and other policies that aid the lagging region. The region will have political representatives…. A third–particularly important–feature is that a nation shares a common set of regulations (in labor, product, and capital markets). Changes in inter-regional trade patterns are unlikely to be the result of what many people feel are ‘unfair trade practices’ or ‘tilted playing fields.’… The boundaries of a nation are defined by shared sense of collective purpose, as embodied, in part, in that nation’s common laws and regulations and in its instruments of solidarity…. So the national market and the international market are different….

A libertarian might view much of the regulatory apparatus of the nation-state as superfluous at best and detrimental at worst. For me, the apparatus is what makes capitalism feasible and sustainable at the national level–and problematic at the global level.

Must-Read: Mariana Mazzucato: Jeremy Corbyn’s Necessary Agenda

Mariana Mazzucato: Jeremy Corbyn’s Necessary Agenda: “We must drop the false dichotomy of governments versus markets…

…and begin to think more clearly about the market outcomes we want. There is plenty to learn from public investments that were mission-oriented, instead of focused on ‘facilitating’ or ‘incentivizing’ business. Policy should actively shape and create markets, not just fix them when they go wrong. Indeed, policies traditionally considered ‘business friendly,’ such as tax credits and lower tax rates, can be bad for business in the long run if they limit governments’ future ability to invest in areas that increase innovation-led growth…. Moreover, we need more patient, long-term finance. Most existing finance is too speculative and too focused on short-term outcomes. Exit-driven venture capital might be appropriate for gadgets; but technological revolutions have historically required patient, committed public financing…. When the public sector takes key risks along the innovation chain… we should think more creatively about the kinds of contracts that enable the public to share not only the risks, but also some of the rewards. We must also shape a new narrative on debt. Rather than focus on budget deficits, we should concentrate on the denominator of debt-to-GDP ratios…